Financial Risk Manager Part 1

The Arbitrage Pricing Theory (APT) indeed recognizes multiple systematic factors. Unlike the Capital Asset Pricing Model (CAPM), which is a single-factor model that only considers market risk, APT is a multi-factor model. It assumes that the return of a financial asset can be modeled as a linear function of various macroeconomic factors. These factors could include GDP growth, inflation rates, interest rates, and others. Each of these factors has an associated sensitivity or 'beta' that measures the asset's responsiveness to changes in that factor. By considering multiple systematic factors, APT provides a more comprehensive view of the risks affecting asset returns. This recognition of multiple systematic factors is the primary distinction between CAPM and APT.

Choice A is incorrect. Both CAPM and APT place emphasis on systematic risks. Systematic risk, also known as market risk, affects the overall market and cannot be eliminated through diversification. It is a key component in both models.

Choice B is incorrect. The statement that APT downplays the importance of diversification is not accurate. In fact, both CAPM and APT assume that investors hold diversified portfolios to eliminate unsystematic risk.

Choice D is incorrect. Neither CAPM nor APT recognizes multiple unsystematic factors as they are based on the assumption that unsystematic risks can be diversified away by holding a well-diversified portfolio.